Tuesday, 26 March 2013

This Sacramento Arena Deal Looks Better

The new Sacramento arena proposal is a significant improvement over last year’s proposal. Overall, I think it generates more value for both the City and the investors, and it appropriately shifts some of the risk away from the City and onto the investors. I will never endorse an arena subsidy for economic development purposes, however if it is the City’s goal to retain the Kings’ and have a downtown entertainment district, then I think this is a good proposal that could accomplish that objective at a manageable cost.

This is the conclusion to my commentary about last year’s deal that the Maloofs rejected:

The Mayor has worked hard to retain the Kings and has come up with the best proposal he could, one that pushes the City to its financial limit, and yet still doesn’t appear to be a better deal for the Kings than the alternatives, including the status quo.The inevitable conclusion is that, like most sports arenas in medium to small markets, a $391 million arena in downtown Sacramento simply doesn’t generate enough new value to equal its cost.No amount of financial engineering is likely to change that.The new arena is simply infeasible without an owner and/or a City that is both wealthy and passionate enough about pro basketball in Sacramento to overlook significant financial risks.Judging from recent events, both sides seem to have an abundance of passion, but a shortage of wealth.

The latest proposal is an improvement along several dimensions. First, the site is shifted from the Railyards to the downtown plaza, in the heart of the City’s existing commercial district. This site has better transportation, highly-compatible adjacent land uses, and should generate more spin-off value to private and city-owned assets (like the convention center) in the vicinity. The railyards site did less for the city’s commercial core, and potentially interfered with housing development and other future uses of the railyard site. In sum, the downtown plaza needs a catalyst like the arena, but I don’t think it is necessary at the railyards site, in fact that development of that area may work better without the arena.

Second, the new Kings investor group would bear more of the risk than the City. They would be responsible for pre-development costs and potential cost overruns, rather than the City. This didn’t necessarily come free for the City, as the city has added 3 small land parcels to the deal compared to last year that are in the vicinity of the arena. Between these parcels, and the remainder of the downtown plaza site, the investors have the potential to capture a significant amount of the spin-off value for the arena. They are also a financially stronger investment group than the Maloofs, and they don’t currently own an NBA team and an arena (something they presumably want for more than just investment returns). Thus, they are more willing and able to bear the risk, and it has been shifted to them.

So how much is the risk to the City? I think the term sheet and the city staff report could be clearer here. The city is going to contribute about $220 million in cash and several land parcels. Most of the cash will come from a bond issue. If we assume 5% interest and 30 year term, and that the city rolls some of the issuance cost into the loan, debt service on a loan of this size would run about $14 million per year (although it sounds like there will be an interest only structure to relieve the burden in early years). The fact that the city will specifically pledge parking revenues for the payments with TOT (hotel) tax as a backstop is an important detail, but the revenue source that city chooses to use for its subsidy is not as important as the amount of the subsidy itself.

The net loss to the general fund will be less than this due to what the proposal calls the “backfill." The proposed amount needed to "backfill” the general fund is the $9 million current contribution of parking to the general fund, but I think this is a deceptive presentation. The bottom line is the city is taking on new debt for an investment, and the question is will that investment generate enough new revenue to pay for the new debt. The new revenue sources are a 5% ticket surcharge, and anticipated increased tax collections such as property and sales tax. The amount of these new revenues is highly uncertain, it depends on ticket revenue, the amount of additional development spurred by the arena, and the increase in visitor spending (i.e. restaurants) in the City that results. I think this will likely be less than the new debt service. Thus, the arena will be subsidized, and my best guess is that it will increase the strain on the general fund by $4-8 million per year.

But before anyone howls too much about that, you need to recognize the City budget subsidizes all sorts of things, including recreation such as parks and theaters. The most relevant comparison in Sacramento would be the Community Center Fund (convention center, community center theater and memorial auditorium). The Community Center facilities do not come close to generating enough revenue to cover their operating expenses, let alone debt service. They are "subsidized" by $16 million in dedicated TOT (hotel) taxes each year, although they also generate some spin-off sales tax and parking revenue that could be deducted from this subsidy. The bottom line is that the subsidy to the Community Center venues is much higher than what is being considered for this arena, and I suspect the arena could give the convention center a boost. My guess is that some people’s position on the arena subsidy has to do with how much they like the arts versus sports.

The arena is no free lunch for the city, and no one should think it is without risk and pays for itself. While subsidized, I think this is a reasonable plan, and clearly better than last year.

As a non-resident and part-time commuter into Sacramento who also happens to be a basketball fan, this plan is all benefits and no cost for me! So I am all for it personally.

About the Author

Ethan Jacob

Author & Editor

I am Ethan Jacob Executive Director of the Center for Business and Policy Research at the University of the Pacific, where I have a joint faculty appointment in the Eberhardt School of Business and the Public Policy Program in the McGeorge School of Law..